Financial rewards hamper internal wrongdoing investigations

Jun 14, 2016
<p>Are SEC whistleblower awards undermining executives&rsquo; fiduciary duties to report misconduct internally?</p>

Last week, the SEC announced its second-largest whistleblower award in the five years the program has existed. A former employee of an unnamed company was awarded $17 million for providing a ‘detailed tip [that] substantially advanced the agency’s investigation and ultimate enforcement action.’

In a news release on June 9, Sean McKessy, chief of the SEC’s office of the whistleblower, touts more than $26 million that five whistleblowers have received in the past month alone. ‘[W]e hope these substantial awards encourage other individuals with knowledge of potential federal securities law violations to make the right choice to come forward and report the wrongdoing to the SEC,’ McKessy says.

The SEC appreciates the time and resources whistleblower tips help it to conserve when collecting robust evidence to support cases against corporate misconduct. But some corporate counsel believe the rewards program is undermining the ability of governance professionals within companies to improve compliance and ethics programs and fix problems internally before regulatory enforcement becomes necessary.

The direction many regulators are taking to encourage compliance officers and other senior executives to bypass internal reporting mechanisms in favor of reporting directly to the government ‘definitely creates huge pressure on the fiduciary duty responsibility that a lot of organizations depend upon,’ says Chip Jones, co-chair of Littler Mendelson’s whistleblowing and corporate ethics practice group. ‘When you have executives who are employed by the company, I think they have a fiduciary duty to first report those facts internally.’

The SEC clearly states that whistleblowers who report alleged misconduct internally before coming to a government agency are still eligible for a reward as long as they come to regulators within 120 days of the internal report. That gives companies ample time to conduct an internal investigation into the charges and follow up with the whistleblower to let him or her know the report has been taken seriously and appropriate action is being taken. Many US companies are exposing themselves to likely enforcement actions by taking longer – a median period of 46 days in 2015 compared with 39 days in 2014 – to close internal probes into reports of wrongdoing, according to NAVEX Global’s 2016 Ethics & Compliance Hotline Benchmarking Report, released in March.  

But the Dodd-Frank whistleblower statute, which led to the creation of the SEC’s rewards program, poses a dilemma for potential whistleblowers by appealing to the darker side of human nature, says Ed Ellis, who shares responsibility with Jones for the whistleblower practice at Littler Mendelson.

To the extent he/she is incentivized by the prospect of financial gain, a whistleblower ‘can complain internally and wait the 120 days [before going] to the government and risk not being the first person in, or risk there being a disclosure in some other form that impairs his/her ability to collect the reward,’ Ellis says. ‘On the other hand, if he/she goes to the SEC the first time he/she hears of [misconduct] before he/she [reports] internally, all he/she risks is the total reduction in the amount of the reward, not the elimination of it altogether.’ Ellis cites research showing that 80 percent to 85 percent of people who become statutory whistleblowers start by reporting internally.

An increase in reported cases of retaliation against employees for reporting wrongdoing is another reason whistleblowers may feel inclined to bypass internal reporting mechanisms, recent surveys show. But retaliation isn’t rising uniformly across all companies, so ‘particularly for a fiduciary like an attorney to say, My friend down the street was retaliated against, so I’m not going to report internally, I think is bad judgment on the part of that fiduciary,’ Jones says.

He believes dysfunctional management practices that foster a divisive environment, encouraging employees to take sides and form camps, contribute to mishandling of internal whistleblower reports. ‘To be able to adjudicate and resolve [disputes] in a way that doesn’t turn into an us-versus-them [dynamic] is an important first step’ toward avoiding the risk of employees taking their complaints to regulators, he says. 

One tool that has helped, he believes, is the use of employee engagement surveys, which allow people throughout the organization to provide assessments confidentially that let senior management and governance officers know what’s working and what isn’t within a company. Such surveys can be particularly helpful in curtailing the tendency for companies to less strictly monitor the activity of senior managers who have been with a company for many years and enjoy high levels of trust, he says.

‘Most likely when people say, He’s been there for 20 years, everybody loves him, if you have a well-designed employee engagement strategy, you may find out his secretary thinks he’s cheating on his expense reports,’ Jones says. ‘You start to find smoke you can investigate, which may lead to something that would [show] this long-held belief that people trust him is in fact [because] people fear him. But you can’t do that unless you have a way to find out that information.’

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